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Stephen M. Mills, CIMA® 

Chief Investment Strategist

2022 has been a challenging year for most investors with major stock and bond market averages suffering broad-based losses since early January.  The stock market officially entered a bear market in mid-June when the broad-based S&P 500 Index (S&P) hit a level that was 20% below its January 3rd peak.1   Currently, the S&P 500 sits at about 18% below its January 3rd all-time high.1

As of the date of this letter, we are currently experiencing the third 10% plus countertrend rally in stocks for this bear market.1  The current rally began in mid-October after stocks had broken below the June lows and negative investor sentiment had hit extreme levels.  The S&P 500 Index rallied 8% from the October lows before stalling out on November 2nd when the Federal Reserve (Fed) announced a fourth consecutive .75% rate hike.2  Although the .75% rate hike was largely anticipated by most economists and strategists, Chairman Jerome Powell’s comments at the post meeting press conference did not sit well with investors.  Powell indicated in his remarks that the Fed would remain vigilant in its efforts to bring inflation under control and he quashed any ideas of a potential change in its tightening policy by stating that it was “very premature” to consider a pause in their rate hike strategy.3  This was not welcome news for investors who had been anticipating an end of the Fed’s rate hike cycle soon. Powell’s comments sent stock prices sharply lower with the S&P 500 Index tumbling 2.5% by the end of the trading session.  In essence, the takeaway for investors was that the Fed would continue to keep its monetary policy restrictive for longer than previously anticipated. 

The S&P 500 Index reversed course yet again on November 10th on the heels of the October inflation report issued by the Department of Labor (DOL) which came in better than expected.  The DOL reported an increase in the Consumer Price Index (CPI) of 7.7% from the same month a year ago, down from 8.2% in September and below Wall Street’s estimates of 7.9%.  Core prices, which exclude food and energy items, rose .3% from September, the smallest monthly gain in a year.4  This positive inflation data sent stock prices soaring during the trading session with the Dow Jones Industrial Average finishing 1200 points higher on the day and the S&P 500 Index rising by 5.5%.1  The S&P 500 currently sits 3950, approximately 13% higher than its October 13th low of 3491.1   We saw a similar rally of 18% in the S&P 500 off the June lows through mid-August on investor hopes that the Fed would pivot from its aggressive rate hike policy soon.  This gain faded after Chairman Powell’s comments at the Jackson Hole Economic Symposium on August 25th when he reiterated that the Fed would continue with its aggressive monetary policy tightening for the foreseeable future.  

This current rally in stocks appears to be once again based on a potential Fed pivot in its current monetary policy.  The Fed has raised the Fed funds rate by 4% since March of this year.  According to a recent Reuters poll of economists, the Fed will raise the Fed funds rate by .50% at its next meeting in mid-December, and the Fed funds rate will peak at between 4.75% and 5% by early next year before the Fed pauses.5  If that is correct, it would be good news for investors in our view.

While we are certainly happy about this most recent rally in stock prices, we remain somewhat skeptical.  So far, the Fed has not indicated any shift in its monetary tightening strategy.  We anticipate that the Fed will raise rates again in December by .50%.  This is lower than the .75% rate hikes the Fed implemented in each of its last four meetings but still an aggressive rate hike by historical standards.  The Fed will get one more inflation report before its mid-December meeting.  If the inflation trend continues downward, we could see a shift in the Fed’s hawkish stance and a possible indication of a potential Fed pause in its rate hike strategy.  On the other hand, if the November inflation report is worse than expected, we would expect the Fed to remain very hawkish in its tone and continue raising the Fed funds rate over its next several meetings. 

We believe that the Fed will pause its rate hike strategy in the first half of 2023 as we potentially see economic weakness and a possible recession.  We believe that it is a growing possibility the U.S. economy will enter a recession sometime in the first or second quarter of 2023, based on current economic trends and indicators. If this were to occur, we believe it will be a mild-to-moderate recession lasting two or three quarters.  If history is any guide, inflation should recede significantly during the recession.  

What does this potentially mean for investors?   Using history as a guide, we believe bond yields will fall and bond prices will rise over the next several months as economic activity slows.  This potentially presents a buying opportunity for intermediate and long-term bonds.  We see potential gains across the high-quality fixed income spectrum which includes, U.S. treasury notes and bonds, high grade corporate bonds and municipal bonds.  Investors can now lock in interest rates of 4% or greater with many of these instruments.1  That level of interest rates is nearly double the levels just one year ago.

We believe the major stock market averages will continue to be volatile over the next few months until it becomes clearer that inflation is abating and the Fed is closer to pausing its current rate hike cycle.  We see the stock market remaining in a trading range through the first quarter of 2023.  Using the S&P 500 Index as our measure of overall stock market performance, we believe the bottom of the range for the S&P 500 will be near the June and October lows in the 3500-3600 range with the top end near the 4100-4200 range.  As of the date of this letter, the S&P 500 is currently sitting nearer to the top end of this trading range.  We believe the bottom end of the range will hold for now, however, if the U.S. economy and corporate earnings worsen more than expected in the first half of 2023, we could see the S&P 500 break below the bottom end of the range.  If that happens, we believe the downside risk is to about 3200 for this key benchmark.  At 3200, the Price to Earnings Ratio (P/E) of the S&P 500, based on projected earnings of about $210 for 2023, would be about 15 times earnings, a historically cheap level in our view.6   Currently, the P/E level of the S&P 500 sits at about 18 times the $210 earnings forecast.1    

While it is difficult to predict when the current bear market in stocks will end, we believe we are closer to the end than the beginning.  Looking out twelve months from now, we see inflation much lower, the end of the current Fed tightening cycle, and improving economic fundamentals for the U.S. economy.  We believe corporate earnings growth will resume by the middle of 2023.  We believe there is a good possibility that the major stock market averages could recover most if not all of their losses from this year by the end of 2023.  From our observation, stocks prices tend to bottom out well before the end of a recession and begin rising in anticipation of better economic fundamentals.  Since it is very difficult to time market movements in our experience, we believe investors should continue to hold equity allocations according to their long-term investment objectives.  We recommend using weakness in stock prices to add to high quality equities where appropriate.   

We understand that these kinds of volatile markets test investors patience and resolve.  Often, the temptation is to temporarily move out of risk assets into safer investments.  However, we could caution against such action unless long-term objectives or risk tolerance have changed. 

We will continue to monitor market and economic conditions and work with you in managing your portfolio.  If you have any questions or concerns, please give us a call. 

Your Trinity Capital Management Team

Tyler TX Location 821 ESE Loop 323, Suite 100, Tyler, Texas 75701. 903-747-3960. 

TCM Dallas, TX Galleria Location 13355 Noel Rd., Suite 1100 Dallas, Texas 75244 214-746-3575 

TCM Nacogdoches, TX Location 1323 N. University Dr. Nacogdoches, Texas 75961 936-560-3930

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S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value. 

Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 "blue-chip" industrial U.S. stocks.

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The Consumer Price Index (CPI) is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.

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